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Looming Brexit magnifies lower-for-longer outlook, fund managers say

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Events following the UK vote to leave the EU have made it more likely that interest rates and bond yields will stay low for a longer period of time than previously thought, as economies around the world operate in an environment of low growth and increased market volatility, according to Newton Investment Management.

Nick Clay, who manages the Newton Global Income and BNY Mellon Global Equity Income funds, said: “The world economy faces a backdrop of low growth, with increased levels of volatility in both economies and asset markets.”

The weak recovery that has been seen, namely in the US economy, is now late in its cycle, he said, and not about to accelerate, as the consensus believed.

Because of this, interest rates and bond yields will remain lower for longer, he predicted.

“The latest events of Brexit simply serve to further the likelihood of this view persisting,” he said.

The best way to invest in this environment is to focus on business models with haven-like qualities, he said — companies unexposed to the economic cycle, with strong balance sheets and robust and predictable cash flows.

Meanwhile, strategists at Russell Investments said political and economic uncertainty following the outcome of the UK referendum had made a recession in the country much more likely.

Wouter Sturkenboom, senior investment strategist for the EMEA at Russell, said: “In the UK, the fallout from Brexit has pulled our growth expectation for 2016 down from 1.5% to 1%, and for 2017 from 1.5% to 0-0.5%.”

He cited Brexit’s direct impact on trade and foreign investment, as well as its indirect effect on consumer and producer confidence.

“We expect the Bank of England to cut interest rates to support the economy at the margin,” he said.

“Volatility, however, often creates opportunity, although the shakeout so far has not been large enough for our process to recommend taking on more risk.”

Because of this, Russell had kept a broadly neutral allocation between equities and bonds since the equity rebound.

At Hermes, group chief economist Neil Williams said the UK’s vote to leave the EU had global implications, and that markets now had to assess the path a new political line-up in the UK would eventually choose to take.

Even if the UK takes the ‘soft exit’ path of becoming an associate member of the EU – similar to Norway, Switzerland or Greenland – this could still take many years, he said.

He noted that large-cap stocks had found a floor since initial falls following the surprise referendum result, and that global market volatility was still relatively low.

“This early stabilisation is encouraging but could yet be premature without further support from central banks,” he said.

“Once the dust settles, the UK economy will, of course, survive, given its entrepreneurial flair, increasing focus on non-EU trade and likely policy loosening by the Bank of England and the UK Treasury,” Williams said.

He said comparisons between Brexit and the 2008 start to the global financial crisis were diluted by several factors.

“US and UK real GDP are each 8-10% up on their pre-crisis peaks, bank supervision looks tighter, and central banks, after a slow start in 2008-09, now have a proven track record of policy coordination,” he said.

Separately, MSCI said Brexit had highlighted the “risk of capitalism without inclusiveness”, making the point that the referendum’s surprise result had shown how social dissatisfaction could affect government policies.

MSCI ESG Research downgraded the outlook for the UK’s ‘A’ ESG rating to ‘negative’ from ‘neutral’ following the UK referendum result.

Linda Eling-Lee, head of ESG research at MSCI, said: “While it is difficult to predict extreme political and social events, it is possible to build models to test a portfolio against potential shocks.

“Some investors have indicated to us the importance of considering the consequences of inequality and popular discontent into their view of risk.

“Their next logical step could be to incorporate those views into a structured programme of scenario testing.”